The 5 percent edge

October 20, 2005

Many online retailers continue to enjoy an unfair advantage over brick-and-mortar merchants across the country, and that will persist until Congress takes much-needed action and makes mandatory the payment of state sales taxes on Internet (and catalog) purchases.

This advantage comes about because unless remote retailers have an in-state presence, they don't have to collect state sales taxes. In Maryland's case, that means purchases of computers at Dell are not taxed, but those at Gateway, with stores here, are - a 5 percent edge for Dell.

To end that advantage, 18 states this month began an important effort to entice online retailers to voluntarily collect sales taxes. States active in the Streamlined Sales Tax Project have agreed to uniform tax rules (while retaining varying rates) and have licensed software vendors to facilitate the voluntary tax collection.

The goal is to solve the problem of collecting the correct taxes for the nation's 7,500 sales tax regimes - thereby overcoming a 1992 Supreme Court decision that in part said taxation is too cumbersome for remote sellers. Internet retailers that sign up are offered amnesty on any back sales taxes they might owe. The hope is that enough will do so to show that online taxation is workable, prompting Congress to require it.

The project is a good idea, and Maryland officials are rooting for its ultimate success. But, in the meantime, the state is not actively participating - unfortunately for merchants here.

This is essentially because to be active in the project, Maryland would have to change certain sales tax rules, resulting in net annual losses to the state of about $25 million - with very uncertain gains from tax collections by remote merchants who volunteer to collect. For example, Maryland could no longer "round up" to the next 20-cent tax bracket - that is, tax a $5.01 purchase as though it were a $5.20 purchase.

Come the day that Congress compels online sales taxes, the Maryland comptroller's office says it could live with such changes because the revenue from required taxation of remote sales to Marylanders might run $150 million for starters - likely more than enough to offset the state's losses.

Yes, Maryland consumers would no longer be able to sidestep state sales taxes on their remote purchases. (And who among us doesn't like that savings?)

But ultimately this is an unsustainable disadvantage for merchants here and in other states competing with the growing universe of online retailers, which account for a rapidly growing share of retail sales. Moreover, for lower-income consumers without computers, Internet connections or credit - and therefore little access to remote shopping - this amounts to a regressive tax system, under which the poor tend to pay more.

There was perhaps a time when there was not a strong case for applying state sales taxes to remote sales. That time has passed. Customers of remote merchants should no longer receive this favorable tax treatment, and brick-and-mortar merchants should be allowed to compete on a level playing field.